How to Estimate the Value of Your Business

As a business owner, it feels surreal to look around years after the inception of your idea to see what you created. You see the jobs you’ve developed, the processes you’ve mastered, and the ways you’ve changed the world. But at some point, you know when it’s time to exit; you feel it in your gut. You’ve done what you set out to do and now it’s time to move on.

When that happens and you’ve decided to sell your business, the first thing you need to do is determine how much your business is worth. You need a business valuation.

Coming up with a business valuation can seem like a daunting task. Let’s go through some simple steps and by the end, it won’t feel quite as menacing of an item on your to-do list. Once that’s done, you’ll probably come up with a number that resembles life-changing financial reward.

Measuring Performance

From the buyer’s perspective, they look at the business valuation as a way of measuring your company’s performance; it tells them how much money they can expect to make as the new owner/operator. In the end, your valuation doesn’t need to be super accurate; it just needs to be an evidence-based estimate that attracts the buyer and seems plausible enough to keep them interested. 

With a bit of uncertainty as an accepted variable, you need to start with applying a multiple to current earnings or revenue. Your valuation will be equal to your earnings or revenue times the multiple applied. Before we get to how to determine the multiple, we need to go over some other key variables.

Earnings

There are two types of earnings to consider—Seller Discretionary Earnings (SDE) and Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA). There’s no need to go into a deep dive about what these numbers represent. Just remember the following formulas.

SDE = (Revenue – Operating Expenses – Cost of Goods) + Your Compensation 

There are two formulas for determining EBITDA. Consistency is key here. Choose whichever formula provides the most accurate reflection of your business’s earnings potential. You must stick with that choice, however, as switching between results to get the highest number is dishonest and could be used against you. If a buyer spots this, they will likely walk away immediately. Your choices are as follows:

1. EBITDA = Operating Profit + Depreciation and Amortization
2. EBITDA = Net Profit + Interest + Taxes + Depreciation and Amortization

If your EBITDA or SDE is zero because you’ve invested heavily in growth, consider applying the multiple to revenue. It’s pretty common for SaaS businesses to accept short-term losses in return for growth. You might focus on product development and marketing right now but pull back on these expenses when you scale.

Before choosing revenue, remember you need to prove you’re capable of such growth. Fail to do so, and your valuation collapses. Reinforce your projections and diligent market research.

Deciding the Multiple

Between Q4 2014 and Q4 2018, Crunchbase reported a median multiple ranging from 4.43 to 9.32, with an average of 6.69. This was for public SaaS companies only, but it’s a good place to start. Now you need to establish where you fit along this spectrum. To justify a higher multiple, your startup should:

• Run by itself or with very little involvement from you.
• Have been operating successfully for over a year.
• Demonstrate growth potential.

You might be able to tick points one and two now. To tick the third, you’ll need to review some success metrics including churn, Customer Acquisition Cost (CAC), and Lifetime Value of Customer (LFV).

Churn measures lost income through net customer losses or downsized commitments. For example, if you have 1,000 customers at the start of the month and only 900 at the end, including any new ones you acquired, your churn rate would be 10 percent. 

CAC should be low, because burning cash to win new customers often leads to startups failing. Investors don’t want to throw good money after bad, so you’ll need to demonstrate a reason for a high CAC if you want to keep that multiple high.

A high LTV might justify a higher CAC or other revenue losses and is a useful way to target customers who offer the best returns. For example, you might pay a higher cost to acquire customers who regularly upgrade or purchase more because their LTV is higher.

Once you’ve reviewed these metrics, you’ll have a good idea of where the needle falls on that multiple range.

Bringing It All Together

In summation, to provide an evidence-based estimate on the value of your startup, you need to do the following.

1. Decide which methodology is most appropriate: earnings (SDE, EBITDA) or revenue. If you own and run a small business, SDE will suit you in 99 percent of cases. EBITDA is a good choice if you’re larger and share operational responsibilities with others. Choose revenue if you’re projecting massive growth.
2. Determine an evidence-based multiple: Use CrunchBase or other startup reports to establish a range of multiples for similar businesses operating in similar industries. Then decide where your startup fits using success metrics like churn, CAC, and LTV.
3. Apply the multiple to your earnings or revenue: This gives you an approximate value that you can use to start conversations with potential buyers. Always explain how you derived the multiple so buyers trust the figure. They might challenge your methodology, but since you’ve done your homework, you’ll easily be able to defend it.

Nothing riles investors more than overvaluation, but you don’t want to undersell yourself either. Do your homework, and the numbers will speak for themselves. Estimate the value of your startup correctly, and you’ll not only attract more buyers, but you’ll be in a strong position come negotiation time.

Remember, the more data you have, the better your valuations can be. Don’t gloss over things that might impact the health of your business, and you’ll have confidence in the final figure. Bringing all these data points together probably doesn’t seem as daunting of a task anymore, so if you’re ready to ride off into the sunset or chase greener pastures with another startup, get going on your business valuation today and get ready for whatever’s next.

For more advice on how to estimate the value of your business, you can find Getting‌ ‌Acquired‌ on Amazon.

Written by Andrew Gazdecki.